Transfer pricing has become a vital part of modern tax regulation, especially as businesses increasingly operate across borders. In Ethiopia, the introduction of Directive No. 981/2024 marks a significant step in aligning local tax practices with international standards. This directive provides detailed guidance on how related-party transactions should be priced to ensure fair taxation and reduce the risk of base erosion and profit shifting.

What Is Transfer Pricing?

Transfer pricing refers to the pricing of goods, services, or intangible assets exchanged between related entities within a multinational enterprise (MNE). Since these transactions occur within the same corporate group, there is a risk they may not reflect market value. To counter this, tax authorities require that such transactions be conducted at arm’s length—that is, on terms that would apply between unrelated parties under similar circumstances.

Directive No. 981/2024 emphasizes this principle and lays down comprehensive rules for its application in Ethiopia.

Scope and Applicability

The directive applies to both cross-border and domestic transactions between related parties, provided their annual turnover exceeds ETB 500,000. It aims to align Ethiopian practice with the OECD Transfer Pricing Guidelines, making it easier for companies to manage compliance across multiple jurisdictions.

Core Principle: The Arm’s Length Standard

At the heart of the directive is the arm's length principle. Taxpayers are required to calculate taxable income as if the transactions with related parties were carried out with independent entities. This ensures that profits are reported and taxed where economic value is actually created.

Approved Transfer Pricing Methods

To determine whether a transaction adheres to the arm's length principle, the directive outlines five approved methods. These include the Comparable Uncontrolled Price (CUP) method, which compares the price charged in a related-party transaction with a comparable transaction between independent parties; the Resale Price method, which examines the resale margin earned after purchasing from a related entity and reselling to a third party; and the Cost Plus method, which determines the appropriate markup on costs incurred in a related-party transaction.
In addition, the directive allows for the use of the Transactional Net Margin Method (TNMM), which assesses net profit relative to an appropriate base such as costs, sales, or assets, and compares it with margins in uncontrolled transactions. Finally, the Transactional Profit Split Method can be applied, which allocates the combined profit or loss from a related-party transaction based on the respective value contributions of each party.
Taxpayers are expected to select the most suitable method based on the transaction's nature, data availability, the level of comparability, and the strengths and weaknesses of each method.

Comparability Analysis

A fundamental element of transfer pricing compliance is conducting a comparability analysis. This involves evaluating whether the conditions in the related-party transaction are similar to those in transactions between independent entities. The analysis considers various factors such as the characteristics of the goods or services exchanged, the functions performed and risks assumed by each party, the contractual terms, prevailing economic conditions, and the business strategies involved. Where differences exist that could materially affect pricing, adjustments may be made to improve the reliability of the comparison.

The Arm’s Length Range

When applying the chosen method, the result often produces an arm’s length range—a spread of acceptable prices or profit margins derived from comparable uncontrolled transactions. If a company’s financial indicators fall within this range, no adjustment is required. However, if the results fall outside the range, the tax authority may adjust the taxpayer’s income to the median of the range, unless there is a justified reason to use another point within the range.

Transfer Pricing Documentation Requirements

Proper documentation is central to demonstrating compliance with transfer pricing rules. Directive No. 981/2024 requires companies to maintain contemporaneous and detailed records to substantiate the arm’s length nature of their related-party transactions.
The documentation must include a Master File, which provides a global overview of the multinational group’s operations, including its structure, business activities, and transfer pricing policies. A Local File is also required, offering a detailed account of the specific transactions involving the Ethiopian entity, including the selected pricing method and comparability analysis.

For large multinational groups, a Country-by-Country Report (CbCR) may also be necessary, outlining income, taxes paid, and economic indicators by jurisdiction. In addition, a Functional Analysis should be conducted to describe the roles, assets, and risks associated with each party involved in the transactions. Finally, Financial Analysis is required to support the transfer pricing assessment with financial statements, ratios, and other relevant data.

All documentation must be prepared by the time the taxpayer files their annual return. Failure to do so may lead to penalties or tax adjustments.

Final Thoughts

Transfer pricing plays a critical role in ensuring tax fairness and transparency, especially in today’s interconnected business environment. Directive No. 981/2024 provides Ethiopia with a modern and comprehensive framework to manage related-party transactions in line with international norms.

For companies operating in Ethiopia, the directive underscores the importance of choosing the right pricing method, conducting robust analyses, and maintaining thorough documentation. Adhering to these requirements not only reduces the risk of disputes with tax authorities but also enhances the credibility and compliance posture of businesses.

As Ethiopia continues to strengthen its tax administration and integrate into the global economy, effective implementation of transfer pricing rules will be key to achieving sustainable growth and fiscal stability.